Navigating The Rocky Road Of Bankruptcy

Whether you are a novice or veteran credit professional,
navigating your way through a bankruptcy can be confusing.

Whether you are a novice or veteran credit professional, navigating your way through a bankruptcy can be confusing. This article should not be interpreted in any way as expert legal advice on bankruptcy, but rather an effort to help clarify some areas of bankruptcy that can be confusing.

You have no doubt heard and read a great deal lately regarding § 503(b)(9) of the Bank-ruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA, 10/2005). This section gives vendors an administrative priority claim for the "value of any goods received by the debtor within 20 days before" the date of the bankruptcy petition filing, as long as the goods were sold to the debtor in the ordinary course of the debtor's business. The value of services are not covered in this section of the code.

At first read, many credit professionals may have believed that § 503(b)(9) was intended as a replacement of § 546 (C). This section of the code provides vendors with a somewhat lim-ited right to "reclaim" or get back certain goods. Under BAPCPA, the goods must have been sold to the debtor by the vendor in the "ordinary course of business" and the debtor must have re-ceived the goods while insolvent. The vendor must make a demand for the reclamation of goods in writing and within 45 days of the receipt of goods by the debtor. If the 45-day period has ex-pired after the bankruptcy case was filed, the vendor must make the reclamation demand within 20 days after the bankruptcy filing.

Vendors who by-passed the opportunity to file a reclamation claim under § 546(c )in hopes of a quick payment by filing an administrative priority claim under § 503(b)(9) are finding out the hard way that such an action doesn't always work. § 503(b)(9) does not specify a time limit on when administrative priority claims must be paid. Two court decisions in 2006 made this point clear, much to the disappointment of vendors in two different bankruptcies.

In re Global Home Products, LLC Chapter 11 case (Bankr. DE), a decision issued by Judge Kevin Gross on 12/21/06 held that the timing of payments of administrative claims is left to the discretion of the court. The court relied on three factors in assessing when an administrative claim should be paid; a) the prejudice to the debtor; b) hardship to the claimant, and c) potential detriment to other creditors. The court applied these factors in its denial of a creditor's claim for immediate payment.

In re Bookbinders' Restaurant, Inc. Chapter 11 case (Bankr. E.D.PA) a decision issued by Judge Eric Frank on 12/28/06 held that the timing of payments of administrative claims is a matter of the court's discretion.

In both decisions, the courts held that they have discretion to delay payment of administrative claims until the end of a Chapter 11 bankruptcy case, upon confirmation of a reorganization plan.

To further confound vendors, debtor's attorneys have been filing motions with the courts to establish special bar dates for the filing of administrative claims and other procedural orders. One such case was In re Brown & Cole Stores, LLC (Bankr.D. WA). In this case, the court granted the debtor's motion which included the following "procedures": a) established a special bar date for filing of creditor's claims; b) required the debtor to file a report evaluating such claims 21 days after the special bar date; c) gave creditors 15 days thereafter to file a reply to the debtor's position; d) made the debtor's position binding in the event the creditor did not respond in the set time-frame, and e) reserved to the court the right to resolve any dispute.

As credit professionals continue to travel the rocky road of reclamation and administrative priority claims under BAPCPA, it becomes more evident that nothing is as it seems on the surface.

Another area of bankruptcy in which nothing is as it seems is § 547, preferences. By now, all credit professionals should be aware of the revisions brought about by BAPCPA with regard to preferences. In case anyone has never been hit with a prefer-ence claim (lucky you), here is a quick recap of what constitutes a preference under § 547: a) any transfer of an interest of the debtor in property (read cash) to or for the benefit of a creditors; b) for or on account of an antecedent debt owed by the debtor before such transfer was made; c) made while the debtor was insolvent; d) made on or within 90 days before the petition filing date; e) made between 90 days and one year before the petition filing date if the creditor at the time of the transfer was an insider, and the transfer enables such creditor to receive more than such creditor would receive if I. the case were a case under Chapter 7 of this title; ii. The transfer had not been made, and iii. The creditor received payment of such debt to the extent provided by the provisions of the title.

More specifically, § 547(c )(2) states: "the trustee may not avoid under this section a transfer to the extent such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the trans-feree (read creditor) and such transfer was - A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or B) made according to ordinary business terms.

Initially, when BAPCPA became effective in 2005, creditors believed that defending a preference claim under § 547(c)(2) would be easier since they had a choice of proving that the transfer (payment) was made either in the ordinary courses of busi-ness between the debtor and creditor or in the ordinary course of business within the relevant industry.

As seen In re National Gas Distributors, LLC , 2006, (Bankr. E.D. N.C.)1 the court ruled that while the creditor only needed to establish one prong of the ordinary course of business defense under the revised statute (BAPCPA), it required the court to consider the ordinary business terms of both debtor's industry and creditor's industry. This is only the latest in a number of decisions that continue to confuse credit and legal professionals alike.

In re Tolona Pizza Products Corp., 1993, (U.S. Court of Appeals, 7th Circuit)2 the lead opinion contained references to establishment of 'ordinary terms' between debtor and creditor, as well as within an industry. The following excerpts should be of interest to creditors: "…...persuade us that the creditor must show that the payment he received was made in accordance with the ordinary business terms in the industry. But this does not mean that the creditor must establish the existence of some single, uni-form set of business terms as Tolona argues….Not only is it difficult to identify the industry whose norm shall govern, but there can be great variance in billing practices within an industry….The law should not push businessmen to agree upon a single set of billing practices; antitrust objections to one side, the relevant business and financial considerations vary widely among firms on both the buying and the selling side of the market."…."We conclude that 'ordinary business terms' refer to the range of terms that encompasses the practices in which firms similar in some general way to the creditor in question engage, and that only dealings so idiosyncratic as to fall outside that broad range should be deemed extraordinary and therefore outside the scope of subsection C……"

In re National Gas Distributors, LLC has been considered the most definitive decision issued since BAPCPA's inception. However, In re Tolona Pizza Products Corp., is still referred to in many preference suits in arguing relevant industry and terms of the debtor and creditor.

In re Bridge Information Systems, Inc., 2006 (U.S. Court of Appeals, 8th Circuit)3 Creditor Gulf Coast Workstation Corp. failed in its appeal of a lower court decision which stated in part…."However, to establish the third prong of the ordinary course defense, the testimony of a transferee employee cannot be evidence merely of the practice between the transferee and the debtor; it must be 'evidence of a prevailing practice among similarly situated members of the industry facing the same or similar problems.'"

The cases cited above are but two examples of why creditors need to hire an outside expert witness who can provide testimony as to "ordinary course of business" between parties and within industries.

And, lastly, § 502(d) of the Bankruptcy Code states that a general unsecured claim cannot be paid if the same creditor is liable for a preference claim owed to the bankruptcy estate. SAY WHAT? Basically, this section prohibits any payment to a credi-tor that has not repaid an avoidable transfer (preference) or turned over property of the estate after they have been found liable for a preferential transfer. Attorneys have been known to use this section as leverage in cases where a creditor has filed an adminis-trative claim under § 503(b)(9).

As most, if not all, credit professionals are aware, bankruptcy preference suits must be filed within two years following the filing date of a bankruptcy petition. In cases where several hundred preference actions may be filed, bankruptcy trustees are filing suits against "John Doe" defendants or "sealed" suits in which the defendant names are unknown. These actions are taken simply to stop the two-year clock from running out and allowing the trustees more time in which to build their cases.

Good luck navigating bankruptcy's rocky road!

1 www.bapcpablogspot.com
2 www.projectposner.org/case/1993/3F3d1029
3 www.caselaw.lp.findlaw.com/data2/circs/8th;05984p.pdf